The Next Big Megatrend is the Shrinking Cost of Distance

Geography used to be destiny, Communities and trade flourished in proximity to food, resources and transportation options. In ancient times that meant rivers and coastal areas. In the industrial revolution, that meant along rail lines and at rail terminals. In the automobile era, that meant along highways and interstates. The cost of distance has been baked into goods and services for so long that it’s almost taken for granted, seen as an absolute or a constant. In recent years, globalization has been driven by a shrinking cost of distance. An American firm moving its manufacturing across the Pacific doesn’t think twice about the cost of shipping back over the ocean because its labor costs are so much lower and containerization of trade drops the cost even further

But what if the cost of distance fell dramatically again? Strategy and consulting firm Bain & Company produced a fascinating report earlier this year that explored the technology-driven decline in the cost of distance. It struck a nerve with us because at Hyperloop we often talk about eliminating distance (and time) through high-speed on-demand travel, and reshaping regions by enabling people to live in more affordable communities well outside a metro area, or to live in one city but work in another 300 miles away separated by a now 20-minute commute

Bain points to a set of emerging technologies such as 3-D printing, robotics, autonomous vehicles, low Earth orbit satellites, drone delivery and the Hyperloop, that will allow people to live and work in a wider variety of places with better quality of life, for manufacturers to shift production to more distributed locations, and for retailers to serve more distributed customers profitably. Drones have the potential to lower delivery costs by 75% to 80%, according to the Bain report, allowing deliveries of smaller packages. Smart kiosks and dexterous robot assistants in casual dining restaurants and apparel retailers can lead to a 25% to 30% increase in the number of locations that chains such as Outback Steakhouse, Old Navy and Apple can profitably serve, according to the report

A structural decline in the cost of distance could lead to widespread shifts in business models, supply chains, and real estate values. The winners would be advanced economies that can deploy these technologies quickly and harness their benefits. The losers would be emerging economies that depended largely on labor arbitrage, commercial real estate developers that made long-term bets on suddenly irrelevant locations and service-economy workers ripe for displacement by automation.

One of the mega shifts, the migration out of cities, is well under way. Bain’s Macro Trends Group analyzed census data for 360 metropolitan statistical areas, defining the urban center as being 10 miles or less from the city center, about the average one-way commute. In 2000, just under half the US population (49.7%) lived within 10 miles of a city center. Ten years later that number had fallen to 47.5%. That’s almost 6 million fewer people living in urban centers, and the migration was split evenly between the suburbs and the exurbs. Bain’s finding may seem to contradict reports about renewed growth of urban centers, but it doesn’t. The total population living within the city-center radius did increase over the decade by 7 million people, but the population of the US also grew. Had these urban centers retained their proportional share of the population, they would have added 13 million people. Instead, the suburbs and exurbs increased their share by 6 million people. That shift away from central cities is even stronger in Western and Southern Europe than it is in the U.S.

We had a chance to sit down and talk with the authors of the Bain report: Karen Harris, managing director of Bain’s macro trends group and Austin Kimson, Bain senior economist:

Why this report? Why now?

Karen Harris: We’re always looking for big drivers in the economy where the assumptions of the market are fundamentally misguided for a reason we can identify. In this case, we were confounded by the general wisdom that by 2050 everyone would live in a megacity. I live in Manhattan so I understand the attraction. But why is it that well-off people who can make other choices would be inexorably crammed into 100-story buildings? We looked at the construct of cities and what they were built to do and realized that the constraint is changing. Some people will continue to choose to live in cities, but that doesn’t mean that people will inevitably cram themselves into cities and our clients who are making these long term bets based on that conventional wisdom should know the counter trend.

What’s been the reaction to your paper?

Harris: One of our big clients, a buyout fund that makes real estate investments, called and asked us to come in and talk to their team right away. For people in technology circles on the West Coast it made a lot of sense, but in some traditional industries like retail they are wondering what it will mean for footfall traffic. Transportation companies tell us they are already seeing this kind of dispersion.

Austin Kimson: People in big cities like New York and Sydney have been scratching their heads at this idea but as you go through the logic, people agree more than they disagree. The richer people have a hard time understanding this. It’s really middle class that has to balance cost, space and affordability. We’re seeing a lot of people moving from California to Texas, Nevada, Arizona in search of more affordable housing.

Where’s the evidence for the boom in distributed or local production? I see it at the artisanal level but is the megatrend really here?

Harris: The far-flung 5,000-km supply chain to China is shortening. A lot of companies we talk to are putting their marginal production closer to market (like Mexico). There is a lot more 3-D printing of complex parts closer to home markets, but massive printing of commodity things like utensils, not so much. But in a decade or a decade and a half, the bigger trend could take hold. Having the ability to reach a wider customer base no matter what means you can specialize more now, too. If you have smaller group of customers to delight you can have localized and lower production. Companies like Amazon that deliver in smaller quantities can offer mass customization in demand. You saw a similar trend play out when the less-than-truckload category emerged separately from the trucking industry.

Kimson: It’s about reducing the scale point, or the ability to be producing at lower volumes with products that are five to ten times better than what they already have. It’s no longer that relevant to look around the world to lower your labor costs by 10% versus asking if you can innovate more quickly than anyone else or do a level of customization that’s just not possible at batches of a million. As with commuting, in the business-to-business market it’s the variability in time that will kill you. Companies are pulling in their supply chains because of the risk of variability. Missing a deadline is just not worth it to them. The opposing trend is that we’re seeing businesses that are able to operate at much smaller scale because they can leverage these global supply chains that much easier. But they’re wanting to extend the supply chain without making it complicated and adding a new source of risk. The history of economic innovation is having your cake and eating it, too. If you could have all your suppliers next door to you that would be great. If you can use something like a Hyperloop to create the equivalent experience in every way (speed, dependability, availability) and your suppliers are now hundreds or thousands of miles away, this is having your cake and eating it too. You’re collapsing the trade-off so it’s not a trade-off.

Your report reveals a shift to the suburbs or exurbs when most people obsessed with millennials believe everyone wants to live in creative-class cities. Retiring to Portland in your twenties is a thing, you know.

Harris: The people who feel the real pressure of cost and space are families. More of what we’re seeing in cities are that they become provinces of rich families, young people who don’t mind piling up, and empty nesters. The rest get squeezed out and move someplace where they can get a four-bedroom house they can afford. I hesitate to say it’s only about millennials because that sounds like it’s attached to a value system but it’s more of a lifecycle thing. The related phenomenon is family size, which is not as much about educational attainment as people think it is. Family size is more of a U curve. Lower income families are larger than middle income families and then size goes up again along with wealth. The reason most families have two kids is because it’s what they can afford and they want to give their children a better life than they had.

Kimson: I live well outside of Dallas, almost an exurb, and my neighbors are a school teacher and a firefighter and are doing the basic math to find out if she can stay at home vs paying for child care. If there is one particular class of cost that is really driving constraints around having children it’s cost of childcare. For many generations the natural arrangement was having a multigenerational household or people nearby. Spatial economics makes it possible to undo the structure that ripped it apart through urbanization. In China younger folks went to cities and older folks stayed in country, but now both groups are facing financial constraints and finding outer places to co-locate.

Let’s talk hard assets, not people. Which assets are the most at risk of being stranded as the cost of distance plummets?

Harris: Those tier B malls in the inner rings of suburbs are the flashing red light danger zones because they’re neither fish nor fowl. You will still need to move your commodity goods around like coal and wood, but the question is what kinds of customers will you hit based on where you locate.

Kimson: The spatial logistics of Hyperloop reminds me of a conversation I had with an airline executive who said that higher spatial dispersion makes feeder patterns even more important. For large-network airlines, their mega hubs and big trunk lines become even more important sources of competitive advantage, but you’re having to feed them from increasingly dispersed population areas. Similarly, a very high-speed point to point route is interesting but how do you feed it? A bullet train between Dallas and Houston can reduce a four-hour trek to 90 minutes but if it takes an hour to get to each station from downtown then I’m back to my four hours. It’s not just the trunk line or mega hub-to-mega hub but the true spatial problem of reducing the time for that point to point travel.

What are the enabling technologies for last-mile logistics?

Kimson: The real crux of the last mile is the neighborhood to front door. I’ve seen rolling robots for groceries, and drones overhead for other goods. They all reduce the cost of distance. But to get a real step change in delivery cost, you either need to relax time-sensitivity (which is the opposite of what everyone wants) or a real breakthrough in last-mile productivity. A UPS driver is only marginally more productive than he or she was in the 1950s but a driver with a fleet of 4 drones would be hugely more productive. The cost of that model is based on a driver going to a central area with a drone pad on top of the truck where takeoffs and landings happen. No matter how I pencil it out I still get drastic reductions.

Retail automation allows for chains to penetrate smaller markets profitably, but that doesn’t mean they’re going to close the old ones, does it?

Harris: No, it will mean more outlets. Will it mean more employees? I’m not so sure. ATMs didn’t replace banks but you have fewer tellers. Branches actually grew until recently as ATMs grew.

Kimson: I live in Keller, Texas, an exurb of Dallas-Fort Worth, and I can get 90% of the things Karen can get in NYC but she can get access to a far wider variety of services that are made available to higher-density areas. The new math that retailers are going to do is to lower their population per trade radius from 100,000 to 30,000. Suddenly they can push into lower-density areas and that in turn increases the desirability of those areas and reduces the services gap in areas such as restaurant varieties and quick-delivery. New business models like DoorDash has really exploded in my area by taking a piece of the value chain that restaurants used to do and spreads it across 30 or 40 restaurants and now all of a sudden I have a lot wider variety. Pasadena is great example of community of the future: a walkable high street and cluster of world class universities. If you live in Pasadena and can work in Pasadena you’ve really got it made.

The shift to suburbs and exurbs was a big surprise, given how much people talk about the resurgence of the city.

Harris: In some countries there is a big city that has tremendous gravitational pull. With Sydney, you see a lot of pull. Tokyo, too. But what we’ve seen in London is that while population has grown, some 600,000 British citizens have left and it’s the non-domestic residents that have kept the population rising. And while Tokyo is an example of death star pulling in energy, cities like Osaka are not.

Kimson: Of the top three metros in U.S., New York is still continuing to create a white-hot center in terms of population density but Los Angeles and Dallas-Fort Worth continue to exemplify population dispersion. Dallas-Fort Worth is one of most rapidly spatial expanding. This mirrors people’s image of 1950s suburbanization, when people lived in a 10-mile radius of the city center, but now at least where I live the outer burbs are becoming self-sustaining. They’re giving people walkability and human-scale development but replicating that in smaller bite-size pieces that enable you to have lower density. My town of Keller is a great example. Ten or 15 years ago there was nothing there. Now a very wealthy demographic is being drawn out here from closer to the city by amenities such as Southlake Town Square (a faux downtown with cool restaurants and shops) and proximity to DFW airport. You have a lot more professionals, sales people and consultants here and mobility is critical for them. I see it in Chicago and somewhat in Denver, where I was poking around and asking the locals where is the development heading. My Uber driver said it’s all happening around the outer most rings and his rides are periphery to periphery instead of clustered in the downtown. The most fundamental insight in this work is that cost of distance is going down and when that happens people will use more of it.